Finally, Lower Bail For Bonds

March 1, 2017

 

 

It only took a few decades, but at long last, price transparency is coming to the bond market. You see, for years, if you bought a stock, the commission amount was plainly stated on your trade confirmation. If you bought a bond, all you were told was the price you paid for it. This was something of a devil's playground for years in the Fixed Income markets. The broker/dealer could add on as much mark-up as they liked, and the average retail client was none the wiser. Not only did this mean mere overpayment, the higher price effectively lessened the yield to the investor for the life of the bond.

 

My first employer was a master at this, especially on two types of products: Collateralized Mortgage Obligations and Zero Coupon Municipals. The structure of both of these instruments lent themselves well to a kind of price camouflage. For the CMOs, variances in payment speeds and the lack of a real maturity date (thanks to prepayments and refinancing) allowed for somewhat opaque pricing.

 

Zeroes were also ripe for this sort of practice. Sold to anxious parents and grandparents to mature at the time of the child's attendance for higher education, maturities ranged from 18 to 22 years. In terms of yield on such a long dated piece, adding on seven dollars per bond - or more- didn't move the yield needle that much. But if the investor had to sell them prematurely, they were hit hard. It took a long time for the bond's value to climb over that fat mark-up, especially if bond market yield wasn't going your way.

So, if someone bought a Zero Coupon issue for $55 per bond, some novel excuses had to be fabricated to explain why the next monthly statement showed them worth only $48.00.

 

The CMOs were worse. The brokers only knew the commission they made on the CMO, which they then split with the house. What they didn't know is that the trading department could have already larded on ten dollars per bond in markup, all of which was kept for themselves. A CMO sold at Par ($100) could sometimes show as worth as little as $86.00 per bond on the statement immediately following the trade. Brokers were given stock excuses for the reasons for this.

 

Eventually, they were caught. Markups as high as 12% were found on CMOs, and some municipals were marked up over 5%. At least that is for the period they were investigated. Thanks to the way the rules are written, there is a very short dated statute of limitations for prosecuting these acts in FINRA's world, and there's no telling how much lucre was accumulated thanks to these practices since the firm's founding.

As an advisor instead of a broker, bonds sold to my clients are never marked up, and in partnership with the resources of the bond desks I work with, clients are assured of getting the most competitive price I can find. It will be interesting to see how traditional broker/dealers cope with disclosing high markups on their bond trades once the rule is imposed. I can safely predict a spike in trading prior to the week the new rule takes effect: May 14, 2018.

 

 

Let them do their worst. I will do my best.

 

 

Regulatory Notice 17-08

SEC Approves Amendments to Require Mark-Up/Mark-Down Disclosure on Confirmations for Trades With Retail Investors in Corporate and Agency Bonds

 

Effective Date: May 14, 2018

 

Executive Summary

 

The Securities and Exchange Commission (SEC) approved amendments to FINRA Rule 2232 (Customer Confirmations) that require member firms to disclose additional transaction-related information to retail customers for trades in certain fixed income securities. Specifically, amended Rule 2232 requires a member to disclose the amount of mark-up or mark-down it applies to trades with retail customers in corporate or agency debt securities if the member also executes an offsetting principal trade in the same security on the same trading day. The amended rule also requires members to disclose two additional items on all retail customer confirmations for corporate and agency debt security trades: (1) a reference, and a hyperlink if the confirmation is electronic, to a web page hosted by FINRA that contains publicly available trading data for the specific security that was traded, and (2) the execution time of the transaction, expressed to the second. These amendments will become effective on May 14, 2018.

 

 

http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-08.pdf

 

 

 

 

 

 

 

 

  •  

Please reload

Featured Posts

The Fed is Just KILLING Us With These Low Interest Rates!

April 6, 2015

1/5
Please reload

Recent Posts

January 6, 2020

August 1, 2019

December 25, 2018

Please reload

Search By Tags

I'm busy working on my blog posts. Watch this space!

Please reload

Follow Us
  • Facebook Classic
  • Twitter Classic
  • Google Classic

FloMartin Securities, Inc.

Donald R. Davret, Investment Advisor Representative

www.sec.gov

www.sipc.org

 

Investment advisory services are offered through FloMartin Securities, Inc, an Investment Advisory firm. The firm only transacts business in states where it is properly registered, or is excluded or exempted from registration requirements.
All investment strategies have the potential for profit or loss. Changes in investment strategies, economic conditions, contributions or withdrawals may significantly alter a portfolio’s performance. There is no guarantee that any specific investment or strategy will be suitable or profitable for a particular client. Past performance is no guarantee of future success. We cannot guarantee that a portfolio will match or outperform any particular benchmark. None of the content should be viewed as an offer to buy or sell, or as a solicitation of an offer to buy or sell the securities discussed.



This website is a publication of FloMartin Securities, Inc. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change.​


Information on this website does not involve the rendering of personalized investment advice, but is limited to the dissemination of general information on products and services. A professional adviser should be consulted before implementing any of the options presented

  • Wix Facebook page
  • Twitter Classic
  • Google Classic